SWS Technology Team Industry Report
Industries covered:
Telecommunications
Wireless
Wireline
Computer
Hardware
Software
Network
Internet
Electronics
By Enhao Li, Giselle Cheung, Kathy Han, and Prajakta Jaju
Telecommunications Industry
General Description:
The Telecommunications industry, characterized by giants such as Nokia, Qualcomm, AT&T, Verizon, and
SBC Communications, has, over the past decade, been transformed by rapid de-regulation and innovation
into becoming an increasingly text and image-based—and decreasingly voice-based—medium of
communication. With the introduction of DSL, the main broadband telecom technology, the industry is
quickly spreading its influence over an ever
expanding audience.
Historically, the telecommunications industry was known to include only telephone companies and carries.
Today, however, the definition has substantially broadened to include many companies that not only provide
primary phone services, but also provide a plethora of related services, including but not limited to cable,
entertainment, and software. More broadly, the telecommunications sector is characterized by the operation,
maintaining, and providing of access to facilities for the transmission of voice, sound, text, video, cable
programming, and any kind of data in general.
Today, the primary telecommunications market can be broadly categorized into two levels: wireline
communications and wireless communications. Although the former has been on the decline in recent years
while the latter has experienced an exponential rise, both are integral components in today’s market. To give a
snapshot of the tremendous growth this subsector has experienced in recent years, one can note that in 2005,
wireless providers had 208 million subscribers and $115.3 billion in revenues, up from 55 million and $28
billion, respectively, just eight years earlier. By mid-2006, the US had a 76% penetration rate of wireless
services in homes across the nation. However, demand for wireline services, though declining, is still everpresent. Demographically, demand for telephone services is directly related to population size, and growth in
the industry is driven by both regional population and economic growth.
Recent trends in the market have been towards governmental de-regulation and market consolidation.
Although the third generational wireless market is still not mature, because of cutthroat competition and high
fixed costs (which serve as an effective barrier to entry) recent trends in the market have nonetheless been
towards industry consolidation (the recent merger of AT&T and Cingular Wireless is just one large example).
As we plow into the 21th century then, we can be certain that the wireless market will continue to experience
growth and penetration.
Valuation Metrics:
There are certain important factors to keep in mind when evaluating a telecom company. To begin with, an
important measure of a telecom company’s health is its ability to generate increasing operating cash flow
(measured by EBITDA); if this is not occurring, it is important to question whether or not the company will
be able to invest and grow in upcoming years. Another important metric to calculate is the company’s
intrinsic value, which is the present discounted value of its future revenues (free cash flows). Capital structure
and access to capital is also very important. With increasing competition from new ventures,
telecommunications companies are seeking funding to continue their growth. In addition to looking at
EBITDA as a proportion of enterprise value one also consider EBITDA/net debt or EBITDA/interest,
which gives an idea of the debt-servicing rate. The higher the ratio, the healthier is the company’s balance
sheet.
Trends/Industry Drivers:
As was noted earlier, the wireless subsector has been growing at an amazing rate. Not only has the number of
subscribers to wireless networks more than tripled in the past decade, but with the innovation of third
generational phones (namely, phones with technologies that provide value-added services such as voice mail,
text messaging, data transfer, high quality speech and voice, multimedia services and more). Recently, the
market has seen an abundance of consolidation. Because of the large fixed costs and high barriers to entry,
the industry rarely sees new entrants. The industry can be divided into local service providers and longdistance service providers. Local exchange carriers (LECs) provide telephone service within their local access
and transport areas (LATAs) through their own lines, connecting customer locations with central office
switches or leased facilities Long-distance toll (inter-LATA) service includes all calls outside the local
exchange and local toll service areas, as well as calls that originate in one LATA and terminate in another, and
international calls. Other industry players are also entering the telecomm industry. The US wireless industry,
through its all-you-can-eat service plans and expanded coverage areas, has taken a dominant share of the US
market in recent years. As of 2004, wireless service providers generated $99 billion in revenues, up from $80
billion in 2002. Additionally, the Telecommunications Act of 1996 marked the beginning of the cable,
multiple-system operators industry investing billions of dollars in hybrid two-way networks of fiber-optic and
coaxial cable.
Key Players:
Many of the key players in the telecom industry offer a range of wireless and wireline services. There are also
companies that primarily offer communications equipment. Nokia and Qualcomm are two of the biggest
players the communication equipments industry. Nokia manufactures mobile devices and is currently
expanding its multimedia unit, which develops mobile multimedia capabilities like mobile photography and
music. Qualcomm develops and manufactures digital wireless communications products. The largest telecom
services companies are AT&T and Regional Bell Operating Companies such as Verizon, SBC
Communications and Bell South. AT&T dominates in the US long-distance operator, while RGOC
companies dominate in regional telecom services.
Historical/Current/Upcoming Events:
During recent years, there have been two notable trends in the telecommunications industry. First, as was
alluded to earlier, there has been a move towards consolidation. Not only have we witnessed a series of
mergers and acquisitions between wireless-wireless and wireline-wireline companies, but there have been a
number of wireless-wireline mergers as well. Secondly, the other main trend in the industry has been towards
convergence—far from being solely phone service providers, today’s telecom giants are starting to offer
multiple servies (video, voice, data, media). This has revolutionized the advertising and communications
markets. Another point of interest is the recent phenomenon of smartphones. The smartphone era, ushered
in by Palm and it’s Treo series, has now come to be dominated by players such as Apple and the iPhone and
Research in Motion and their Blackberries. Similar to the ongoing trend of moving from first and second
generational utility phones to multimedia third generational phones, it can be expected that there will be an
analogous move towards smart phones is the near future.
In general, the telecom market seems to have very positive prospects. Wireless third generational services
obviously still have a huge market to tap into, but even for wireline service providers, despite the notable
decline in wireline services, S&P nonetheless projects a bright outlook for the sub-sector’s future. They
believe the market stabilized in 2006 and see the trend continuing in upcoming years. Furthermore,
consolidation over the past years has enabled the major carriers, like AT&T and Verizon to streamline
business and generate more cash flow for growth. The S&P also predicts that many wireline service providers
will also generate cash flow through growth in wireless markets, allowing them enjoy a slow and steady rate of
growth.
Computer Network Industry
History
Computer networking has gained widespread importance in the U.S. and global market. Yet this is only a
recent phenomenon, of only two decades. Various forms of computer networks have been around for
decades. Over the years, networks have become more complex. A network is simply two computers being
connected (by a cable) to allow an exchange of information. Today’s networks are typically far more complex,
involving a collection of computers, printers, and other devices that transfer information to one another over
some transmission medium.
Data networking equipment is the hardware that constitutes the infrastructure of a network, consisting of a
variety of switches, hubs, routers, network interface cards (NICs), and other devices. These devices provide
communication between the network’s components at varying levels of speed and service.
Description
The networking sector is a major part of the technology sector. Since the 1990s, communications and
information industry has transformed into a rapidly expanding industry. The companies provide ethernet
switches, routers, mobility equipment, access equipment, and optical transport equipment. In the past years,
there has been a considerable amount of consolidation. For example, Cisco made many acquisitions in the
early 2000s
Sales in routers have seen a slump, falling 53% in 2002 since its initial decrease in 2001. Access gear revenues
declined 30% to $4.8 billion in the same year. In the mobility infrastructure, it is estimated that there was a
decline of 16.4% that year. The reasons for the market decline is that increase sales of of wireless handsets
have slowed down the subscriber growth, causing fierce price competition. These financial troubles of many
wireless carriers have prevented the adoption of the newest equipment. Additionally, there have been
technological glitches, such as performance and interoperability issues, in introducing new equipment. These
delays have also postponed the benefits expected from introducing new equipment at higher prices.
Valuation
The key areas of valuation include a company’s worldwide shipment of personal computers. The greater the
PC growth, the greater the networking demand. It is also important to watch the Global Sales Report, which
monitors the shipment of semiconductors, of which network vendors are huge buyers of. If a key
semiconductor supplier to the networking industry reports lower
billings, it may suggest that networking vendors ordering less because of slowing demand. Business capital
spending is also important to assess how a company is investing in information technology to maintain a
competitive edge. Real Gross Domestic Product to remain aware of the overall health of the U.S. economy.
Currency exchange rates must also be monitored. The multinational nature of the computer industry means
that the exchange value of the dollar is of great importance.
Additionally, sales and margins should be examined. In a period of strong growth, it is important to consider
sequential growth from quarter to quarter. A variety of variable such as sales mix, sales volume, component
costs, and competitive pricing pressures, can affect gross margins. For networking vendors in general, the
industry’s strength, created by new products and consolidation of power among vendors, has created optimal
gross margins. Expenses, especially for R&D, are important to watch. The operating profit margin (operating
profit divided by net sales) is also important because it notes a company’s ability to make a profit off of the
sale of its products.
Careful analysis of the accounts receivable line can show how well a company’s products are selling. For
example, a rising accounts receivable could mean that sales increased in the last few weeks of the quarter.
Inventory positions must also be closely monitored since a rapid product cycle could lead to inventories
becoming obsolete.
In terms of valuation metrics, the P/E, P/S ratios and EBITDA are very important in evaluating a company.
Trends/Industry Drivers
Experts say that the industry is expected to grow as much as 15% within the next five years as consumers
continue to demand networking services. Currently, there has been a shift to a new focus on data by
telecomm networks. Technology for telecommunications equipment is thus expected to make a transition
away from circuit-switch technology toward packet-based networks. Thus, data networking equipment
vendors are looking to benefit from participation in the worldwide market for broadband
telecommunications equipment.
The demand for networking equipment came from a variety of areas. The demand for personal computers
increased and people were connected to local areas. Business networks also changed. Additionally, the
convergence of voice, data, and video technology, and continued industry consolidation are all affecting the
industry. The huge surge of the internet starting in the 1990s has continued to put networking equipment in
high demand. The high demand for the internet from private homes as well as corporations has pushed
service providers to invest in the latest networking equipment — routers, high-speed switches, and remote
access products — to upgrade their networks to meet the demand.
Large corporations require local area networks, increasing business efficiency, helping to stream line
operations and allow companies to better meet customer service demands. Newer optical networks in
comparison to voice networks allow the transport of data and photons with greater bandwidth and flexibility
of service. Additionally, their scalability allows for more cost efficient network. Large companies have also
found that instead of internally developing new technology to meet demands, it is often more effective for
them to simply acquire small start-up companies that develop this new technology.
Now, instead of the consolidation trend of the late 1990s, companies are looking to spin off their enterprise
data networking divisions as they pursue the high-growth, but long-term, opportunities. In addition to the
major players, there has also been a rise of niche vendors: companies specializing in only a few segments or
technologies (such as ATM, remote access, and so on), instead of providing a comprehensive set of solutions
usually offered by the major network equipment companies.
Performance
In this highly dynamic and competitive market, continual development of new products is essential and the
transition to these new technologies provides an on-going challenge for these companies. These network
companies compete for three kinds of customers: large corporations, governmental organizations, service
providers including telecommunication carriers, cable companies, wireless communication providers, internet
providers, and small businesses, home offices, and residential users.
They must be constantly alert to changes in technology as well as to customer buying patterns. The key to
success in this industry is to adapt and apply new technology quickly. Thus, the ability to accurately forecast
end-user demand trends is especially important.
Players in the industry
The major players include Cisco Systems, which from 1993 to 2000, had a 71 acquisitions. Nortel, another
active company in the industry, had a fewer 9 acquisitions from 1999 to 2000. There has also been
consolidation between large traditional data networking equipment vendors and telecom equipment suppliers.
Most of it has already occurred, such as the $9.1 billion acquisition of Bay Networks by Northern Telecom
(now Nortel Networks) in August 1998 and the Lucent Technologies acquisition of Ascend Communications,
a leader in data networking equipment, for $16 billion in June 1999.
Computer networking is like any high-growth segment of the technology sector and competitive conditions
can change quickly and dramatically. In the mid-1990s, four vendors dominated the networking industry:
Cisco Systems, 3Com Corp., Bay Networks (acquired by Northern Telecom in August 1998), and Cabletron
Systems Inc. In August 2001, Cabletron split into two new companies: Enterasys Networks Inc. and
Riverstone Networks Inc. These companies’ ability of these networking companies to identify and exploit the
market opportunities presented by the technologies and devices has been a key factor in determining their
competitive positions today. For example, all of these companies were able to benefit early one from the
shared-media revolution of the 1980s, and each dominated a specific product area. Bay and Cabletron were
leaders in high-end hubs, Cisco in routers, and 3Com in network interface cards. However, in 1996, the
competitive landscape changed because Bay and Cabletron were slow to changing to the latest technologies.
INTERNET
July 2007 – 1.2 billion internet users around the world, up 225% since 2000
Number of internet users in UC is rapidly approaching the number of wireless users (241 million)
Key trends:
 Online advertising is HUGE (revenues reached $16.9 billion in 2006, up 35%)
 Mobile internet is growing rapidly, especially in countries like China
 Online video – growing rapidly due to influences like Youtube
 Video advertising is the new frontier
 Web 3.0 and social networking
 96% of people age 9-16 connect to an online networking site at least once a week
 MySpace, Facebook
Google has been a major defining player driving the growth in the internet industry (leader in search,
powerhouse in online advertising). Yahoo and Google combined have more than 50% of market share.
(Google is search, Yahoo is display ads)
Future revenues lie in Mobile internet advertising (market expected to rise from $421 million to $4.7 billion
from 2006 to 2011)
Factors that have driven the rapid growth of the internet:
 Increased affordability and accessibility of personal computers
 Development of Wi-Fi
Wireless internet demand is expected to rise greatly in the future—this is where the future market lies
Valuation:
Important to realize that the industry is only slightly more than a decade old
 Makes qualitative assessments all the more important
 Companies should be valued on their prospects of being able to generate future growth
 Management expertise and ethics is key
 Good business model – diverse set of sources that money is coming in from
 Important to watch the competitive landscape and evaluate a company in the context of its
competitors
 Revenues and operating expenses
Computer Hardware and Software Industry
Intro
The U.S. computer hardware industry is one of the biggest in the world. At one point in time, this industry
was selling 150 million units in one year, (jpmorgan.com) but as the economy appears to be on the downturn,
things are likely to change for PC makers too. Now more than ever before, the companies in the computer
industry are competing as fiercely as possible - they are fighting for new customers and are targeting markets
previously unexplored. Traditional approaches and market strategies are giving way to newer ideas and
innovative moves.
The highly competitive PC market is the largest sector of the computer hardware industry in terms of both
units and dollars. It represented about 78% of the total amount spent on PCs, servers, and workstations in
2006. As estimated by IDC, PC units shipped worldwide in 2006 numbered roughly 208 million units and
were worth nearly $217 billion. Unit shipments grew to 229 million in 2006.
.
Trends
With consistent pricing pressure in the industry, the PC market witnessed rising market share concentration
among the top vendors during the past few years. Only the fittest PC producers have survived. In 1992, the
top 10 worldwide vendors accounted for roughly half of the market. From 1999 through 2002, however, just
the top five vendors commanded nearly half (45%) of the market. As of 2006, that level had climbed further,
and the top five held 51%. The computer industry has experienced considerable consolidation, a trend that
Standard & Poor’s expects to continue. By far the largest merger in the industry to date was the May 2002
acquisition of Compaq by HP, valued at some $19 billion.
Though it is believed that big players like Dell, Compaq, IBM, and HP are too secure in their market shares
to worry about new entrants in the field, we believe it would be wise for them to take into account the many
new firms are emerging. However, due to the oligopolistic nature of the hardware industry, new companies
may emerge and die before surviving the highly competitive and consumer-loyal industry.
Meanwhile, the software industry continues its trend toward greater consolidation, with Oracle, Symantec,
IBM, and HP all completing at least $1 billion in deals. We believe this trend will continue, particularly within
enterprise software, as this trend is driven by capital expenditures, which remain strong in the face of slowing
GDP growth. Enterprise software appears to be a high-growth pocket of the software industry because
companies are demonstrating increasing demand for software to improve their productivity.
Key Players:
Compaq, IBM, Dell, Gateway and Hewlett-Packard are key players, however, Dell and Hewlett
Packard dominate. They have significantly more share than their closest competitor on a worldwide basis, and
in the domestic market they account for roughly half of US shipments. Smaller, second tier providers include
companies with well-known brands, some with annual sales exceeding the billion mark. Large Asian providers
such as Acer are commonly categorized as second-tier PC vendors. The bottom of the PC pyramid is
comprised of companies ranging in size from regional systems integrators to single-owner shops offering
built-to-order systems. Many of these companies sell non-branded, or “white box,” PCs.
Key players in the software sector include Microsoft (MSFT), which recently unveiled its upgraded operating
system Vista, as well as Oracle (ORCL). Microsoft is the largest company in the software sector in terms of
market cap (282 billion). It develops and manufactures software to increase productivity for PCs, servers, and
distributed working environments through its five main segments: Client, Server, Online Services, Business,
and Entertainment. Due to its extensive range of products and services, Microsoft competes with companies
in multiple sectors, including Apple, HP, IBM, Oracle, Google, Yahoo, Nintendo, and Sony. Oracle is more
specialized, focusing on its efforts on enterprise software through two divisions: software and services.
Valuation
Business capital spending. Despite the increased importance of the consumer in the computer hardware and
software markets, large corporations and small office/home office (SOHO) businesses remain the primary
drivers of spending on information technology (IT) and enterprise software. Corporate spending represents
about 80% of all technology spending, and economic conditions that depress business capital spending have
significant negative consequences for computer hardware sales. Although well-established hardware and
software companies typically have stable balance sheets, it’s important to keep track of a company’s year-toyear R&D expenditures, partially because accounting guidelines allow some software development costs to be
deferred and thus amortized over several years.
Consumer confidence. Consumer confidence is an important element in corporate profitability, which in turn
drives business capital spending. Additionally, as PC penetration in the home increases, businesses must
invest more in their IT infrastructure to handle increasing demand for e-commerce transactions and other
high-tech services.
License and subscription revenue. For the software industry, license revenue is particularly important, as it is
our most accurate indicator of demand for a company’s software. License revenue is non-recurring, as a
company must continue to sell licenses to generate revenue. Subscription revenue, or the revenues generated
by a subscription agreement allowing a consumer to use the software for a limited time period, is increasing in
importance because it is a recurring type of revenue. Recurring revenues are generally related to greater
financial stability.
Software/Hardware sales. Since software and hardware are complementary goods, we should keep track of
the software market while studying a hardware company, and vice versa. Increased hardware sales could
indicate a demand for more software.
History
The modern computer hardware industry began in the early 1980s with the introduction
of the personal computer (PC). Before then, computing was dominated by International
Business Machines Corp.’s (IBM’s) mainframes and confined mostly to computer professionals and scientists.
As the PC market matures, manufacturers have addressed affordability and innovation as ways to expand
market opportunity.
The software sector developed to support the advancement of computer hardware, and thus historically
follows the hardware sector very closely. In the U.S., the software industry is largely mature and saturated, but
we can continue to forecast growth as software demand in developing countries continues to grow at a rapid
pace.
Companies to follow: Dell, Gateway, Sun Microsystems, Microsoft, Oracle…
Hoovers.com
S&P Industry Report Electronics Sector
Description
Definition of Sector
The Industrial/Commercial Machinery and Computer Equipment industries make up the electronics sector.
Products included under electronics include PCs, monitors, TVs, as well as telecommunications equipment.
Major Electronics Company Characteristics/Key Players[1]
Electronics sector leaders include:
1. Tyco Electronics Ltd. (TEL) – produces engineered electronic components for a number of consumer
and industrial products; network solutions and systems for telecommunications and energy markets, and
wireless systems for critical communications, radar and defense applications. The company not only designs
and manufactures, but markets these products to consumers as well as a range of industries (including
automotive, appliance, aerospace, defense, telecommunications, and computers). TEL’s stock is currently
valued at $36.50. The company is relatively undervalued with a P/E ratio of 29 relative to the industry
average of 22. Its market cap is 17.8 billion.
2. LG Philips Ltd. (LPL) – produces and ships thin-film transistor liquid crystal displays (TFT-LCD)
panels in a range of sizes for use in televisions, notebook computers, and desktop monitors. The company is
currently valued at $24.46 a share. LPL’s P/E ratio is 29. Its market cap is 17.1 billion.
3. Eaton Corp (ETN) – encompasses four business segments: Electrical, Fluid Power, Truck and
Automotive. These segments design, manufacture and market a variety servicing equipment to improve
performance, fuel economy, and safety. ETN is currently valued at $100.88 a share. Its market cap is 14.5
billion.
Market Overview
Many U.S. companies invest in foreign consumer electronics markets, the biggest of which are China, Brazil,
Mexico, and India. [2] Individually, each of these markets produces at least US$8 billion in sales. China’s
electronics market is currently four times this size and continues to grow twenty percent annually as a result
of improving domestic markets and low export costs. The U.S. and Japanese markets are relatively mature
and saturated, so we see the most potential for growth among the aforementioned foreign burgeoning
markets.
Valuation Metrics
Industry Statistics
Valuation Ratios
Financial Strength (mrq)
P/E (ttm)
22.04
Quick Ratio
1.65
P/Sales (ttm)
2.24
Current Ratio
2.54
P/Book (mrq)
4.01
LT Debt/Equity
52.80
P/Cash Flow (mrq)
16.21
Total Debt/Equity
62.80
Profitability (ttm)
Mgt. Effectiveness (ttm)
Gross Margin %
30.95
Return on Invstmt %
9.37
Operating Margin %
8.47
Return on Assets %
6.92
Net Profit Margin %
9.43
Return on Equity %
18.72
Trends/Industry Drivers
Performance
In general, the electronics sector outpaces the S&P 500. In the past three months, the sector grew 14.07% to
the S&P 500’s 1.94%. In addition, we see greater consolidation in recent months, with LED Holdings and
Lighting Science Group joining forces, and Onex acquiring Husky Injection. Much of this sector growth is
spurred by the development of new products as well as the lowering of costs through outsourcing.
Risks
The U.S. electronics market is saturated, and we see foreign markets overtaking our domestic market. A
simple glance at the shelves of your local electronics store tells you that Japanese, Taiwanese, Chinese, and
Korean brands are dominating both the domestic and foreign markets. Consequently, we see investment In
U.S. electronics companies as risky due to increased competition from Asian corporations. Alternately, we
also see risks in Asian investments due to the relative lack of intellectual rights in China and consequent legal
costs. In addition, greater government regulation may pose a risk if the government places market saturation
above generating profits.
Current Events
In Chinese news, President Hu Jintao has demonstrated a strong interest in developing intellectual property
rights protection, with several court cases setting precedents and strongly indicating greater IP protection in
China and Hong Kong. This could present issues for electronics companies who generate profits via product
infringement. Similarly, it could also spur the market by generating an atmosphere for technology
development that ensures rewards for work.
[1] http://www.reuters.com/
[2] http://www.mckinsey.com/mgi/publications/newhorizons/consumer_electronics.asp